When Finance Becomes a Regulator

Financial firms have long stood at the intersection of business and regulation. In recent years, that intersection has turned into a governance channel in its own right. States and international organisations are increasingly using banks, insurers, fund managers, and institutional investors as surrogate regulators—private actors tasked with achieving public objectives by shaping or constraining the conduct of others.

In my recent paper I describe this phenomenon as the financial surrogate regulatory approach: a form of indirect regulation that leverages the financial sector’s control over money and funding flows to extend the state’s reach into the market.

The logic is compelling. Financial firms are heavily supervised, deeply embedded in the economy, and possess detailed knowledge of their clients. By requiring them to monitor, report, or even enforce norms on behalf of the state—whether for anti-money-laundering, tax compliance, or environmental and social performance—regulators can influence vast networks of businesses and individuals without resorting to direct command-and-control measures. The global diffusion of the Equator Principles for project finance, the Principles for Sustainable Insurance, and the Principles for Responsible Investment for asset managers demonstrates how this model has become part of mainstream governance. Stewardship codes in markets from the UK to Japan further entrench the idea that finance can act as a gatekeeper of corporate behaviour.

Yet this apparent efficiency conceals serious constraints. Financial institutions are not neutral conduits; they are profit-seeking entities responsive to market demand and competition. When regulatory obligations clash with commercial interests, enforcement may become selective or purely formal. Excessive demands can even drive clients or capital toward less regulated sectors, undermining both compliance and market integrity.

Information and monitoring costs are another fundamental issue. Collecting and verifying data—such as emissions metrics or social impact indicators—requires expertise and resources that many financial institutions lack. These costs are often passed to customers through higher fees or restricted access to credit, transferring a public burden onto private actors and potentially exacerbating inequality.

Within firms, compliance often struggles to move beyond procedure. The more complex the rules, the more likely it is that staff treat them as boxes to tick rather than norms to internalise. This tendency fuels window dressing—the appearance of diligence without substantive change—and contributes to “greenwashing” and “ESG-washing,” where documentation and disclosure replace meaningful transformation. Free-rider effects can also arise when some institutions shoulder due-diligence costs while others exploit the reputational benefits without similar effort. 

The political use of finance—seen in sanctions enforcement, tax transparency initiatives, and ESG investment mandates—illustrates both the power and danger of this model. Delegating state authority to private intermediaries can achieve rapid, visible outcomes, as the global sanctions against Russia have shown. But it also blurs the line between public responsibility and private discretion. Once banks become instruments of foreign-policy enforcement or ethical screening, questions emerge about accountability, legitimacy, and consistency across jurisdictions.

These dynamics expose a deeper tension. Surrogate regulation depends on aligning public objectives with private incentives. When compliance advances business interests—reducing risk, protecting reputation, or meeting investor expectations—delegation works smoothly. When it does not, the system risks superficial adherence or active resistance. Policymakers cannot assume that financial institutions will act as faithful extensions of the state unless the underlying incentive structures make doing so worthwhile.

Design therefore matters. Objectives must be clear and proportionate to what financial institutions can reasonably control. Information and monitoring costs must be minimised, whether through standardised data frameworks or public-private cooperation. Above all, surrogate regulation must complement, not replace, direct state oversight. The credibility of any regulatory regime ultimately depends on the government’s willingness to enforce its own laws, not merely to outsource enforcement to private intermediaries.

The broader implication is that finance cannot, and should not, bear every burden of governance. The temptation to enlist it as a universal enforcer—on everything from climate transition to human-rights due diligence—is understandable but risky. Delegation may buy speed and global reach, yet it can also obscure responsibility and weaken democratic control.

As states continue to “weaponise” finance in pursuit of public goals, the challenge is to recognise both its potential and its limits. The financial surrogate regulatory approach offers valuable leverage where interests align, but it is no substitute for thoughtful, accountable policymaking. Effective governance requires not only cooperation with financial intermediaries, but also an honest appraisal of what finance can—and cannot—regulate on behalf of society.

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Christopher Chao-hung Chen is an Associate Professor, College of Law, National Taiwan University.

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This blog is based on a paper presented at the Asian Corporate Law Forum (ACLF). Visit the event page to explore more conference-related blogs.

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